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June 17, 2013

Another Economic Crisis Brewing? How to Protect Client Portfolios

The financial crisis of 2008 brought to mind the possibility of a major economic collapse. Since then, there has been an increase in the number of individuals who believe another, possibly worse collapse could emerge. There are certainly a number of factors that could support such a disaster. In this post, we'll discuss some of these factors and what investors can do to help shield themselves from it.

This may well be the weakest post-recession recovery since the Great Depression. Actually, the recoveries following the recessions in 1990 and 2000 were also very weak. However, this time around, even with the massive monetary infusion courtesy of the Fed, our economy is still muddling along at a 2% growth rate. Further evidence is found in the apparent nervousness of investors; at the mere hint that the Fed might reduce its QE, stocks tumbled. Then there's Europe. Recently, France's president said that the crisis was over. Over? Really? Couple this with Japan's 24-year deflationary dilemma and China's export economy slowing and you have a recipe for a global economic fallout. This is the case even though a large portion of the world's central banks are aggressively expanding their money supply.

It's not my intent to forecast, prognosticate or portend such a disaster, but to discuss what we as advisors can do to help our clients if it should appear. With that, I'd like to move to the solution.

In past years, I have used mutual funds for the majority and ETFs for a small portion of portfolios. This is mainly because there are so many quality mutual funds to fill the traditional stock and bonds categories. Until the past couple of years, I believe this was the case and that ETFs were stronger in the alternative space. Today, I think this has changed as there are a number of excellent quality ET's for the stock and bond categories.

Here's the idea. Let's assume you can identify good quality ETFs in every category in which you invest. In short, there would be few, if any, mutual funds in the portfolio. By adding trailing stop orders (TSO) to each ETF, with a predetermined percentage, you could effectively place a safety net under the portfolio in the event markets collapsed. However, if prices rise, the TSO would rise with it, and at some point, the TSO would be equal to and even higher than the original purchase price. This would guarantee a profit. To reiterate, if the doomsayers are wrong, and markets rise, the TSO would rise as well. If the chicken-little syndrome does materialize, then you have a predetermined downside on the portfolio.

If this is unclear, send me an email and I'll make sure to go into more detail in my next post.